THALES FINANCIAL REPORT BUSINESS REVIEW SHAREHOLDER INFORMATION

Transcription

1 THALES FINANCIAL REPORT BUSINESS REVIEW SHAREHOLDER INFORMATION ANNUAL REPORT 2006

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3 CONTENTS Persons responsible for financial information. Overview. Timeline. Key figures FINANCIAL REPORT 11 I. Directors report. II. Consolidated financial statements BUSINESS REVIEW 77 I. Business description. II. International presence. III. Research & innovation SHAREHOLDER INFORMATION 121 I. Company and share capital II. Corporate governance III. Stock market information and financial communication IV. Annual General Meeting of 16 May Table of contents Annual report THALES 2006 _

4 Persons responsible for financial information Patrice Durand, Senior Vice President, Finance and Administration Sylvie Lucot, Vice President, Investor Relations Thales 45, rue de Villiers Neuilly-sur-Seine Cedex France Tel: +33 (0) Fax: +33 (0) ir@thalesgroup.com 2_ Annual report THALES 2006

5 Overview Traditionally described as professional electronics, the Thales Group s businesses are primarily dedicated to critical information systems for defence, aerospace (aeronautics and space), and security applications, in particular for ground transportation. Information systems and infrastructures are considered critical if they provide services that are essential for people s lives and livelihoods and underpin a country's economic and political machinery. Thales solutions span all the functions in the critical information loop, from detection and data processing to communication of information to the relevant people, decision support, response management and reporting on any action taken. Today, effective information management is a key requirement of Thales's customers. Critical information systems and information dominance have become a major priority for the armed forces, but defence markets now only account for roughly half of Thales's revenues. The company's non-defence customers often have similar needs in that secure information management has become critical to their operations. This is the case in the air transport sector, traditionally the company's second largest market, and in ground transportation, particularly rail transportation, where Thales significantly strengthened its operations at the beginning of 2007 with the acquisition of the rail signalling businesses of Alcatel-Lucent, and in the growing markets for civil security. Thales provides security solutions for infrastructure, people and goods, and is experiencing rapid growth in this sector, mainly to meet demand from administrations, infrastructure and network operators, and major corporations. In civil security markets, Thales benefits from three main competitive advantages: - an outstanding portfolio of innovative products and technologies. All Thales businesses draw on a common core of technologies revolving around information management and superiority, real-time distribution of information, and complex systems engineering and architecture. A network of 20,000 engineers and technical staff operating in all Thales subsidiaries around the world constantly enhances this core of technologies through the company's research and development programmes, - solid experience of the defence sector, with recognised expertise in mission-critical system integration and large-scale programme management, - a positioning as a global player in security markets, with an extensive international presence in more than twenty major countries. Thales refers to this international presence as multidomestic to emphasise the excellent relations that the company has established with local customers and the local industrial fabric in each of its countries of operation. This positioning also provides the company with a solid basis for managing its international operations. Expanding the international dimension of the company's operations continues to be a major strategic priority. The data and comments on individual business sectors in this report reflects the organisation introduced by the company in 2004, which was in place throughout 2006: - the Aerospace division covers three major segments: equipment for civil and military aircraft, mission electronics for combat aircraft, and airborne surveillance & mission systems for armed forces and civil security authorities, - the Air Systems division serves two main markets: air defence and missile systems for military customers, and civil air traffic management systems, - the Land & Joint Systems division develops networkcentric systems and network-enabled equipment for land forces and joint and allied commands. It also draws on its dual technology capabilities to develop tailored offerings for selected civil customers, - the Naval division focuses on four key areas of expertise: warship prime contracting, systems for surface ships, underwater systems and naval services, including maritime security, - the Security division leverages the company's technology expertise to provide risk management solutions for civil, government and private-sector customers, - the Services division capitalises on Thales s experience in providing IT services, simulation-based training and other services to military and aerospace customers, with an extended offering tailored to major government, institutional and enterprise customers. The major strategic operations finalised in 2007 are expected to lead to a number of organisational changes within the company. Annual report THALES 2006 _3

6 Timeline Origins 1968: The professional electronics businesses of Thomson-Brandt (previously CFTH) merge with the Compagnie Générale de Télégraphie Sans Fil (CSF) to form Thomson-CSF. Compagnie Française Thomson-Houston (CFTH) was formed in 1893 to operate the patents of the US Thomson-Houston Electric Corp in the emerging market for power generation and transmission. CSF was founded in 1918 and became a pioneer in broadcasting. With its subsidiary Société Française Radioélectrique (SFR), acquired in 1957, CSF was a key player in the 1930s development of broadcasting, short wave, electroacoustics and early radar and television systems.) : The company receives its first major export contracts in the Middle East, after the 1973 and 1979 oil crises. It diversifies into telephone switchgear, silicon semiconductors and medical imaging (CGR). Strategic refocusing on professional and defence electronics 1982: In February, the parent company Thomson SA is nationalised. The financial situation of Thomson-CSF is very weak, its portfolio of businesses highly diversified, and its market share in many areas too small to be profitable. Despite the inflow of revenues from the first major contracts with the Gulf States, debt remains high : The financial situation is turned round by refocusing on professional and defence electronics. The company divests heavily in civil telecommunications in 1983 (agreement with CGE, which later became Alcatel) and the medical sector (sold to General Electric in 1987). The semiconductor businesses are merged with those of the Italian group IRI Finmeccanica in 1987 to form SGS-Thomson. Financial performance also benefits from the finance activities developed in-house from 1984 to manage cash flows from major export contracts. This finance business is progressively taken over by Crédit Lyonnais from 1990 to 1993, in exchange for a stake in the bank. Building a multidomestic company: from Thomson-CSF to Thales : As early as 1987, Thomson-CSF anticipates the inevitable cutbacks in defence spending and, as its major ongoing export contracts draw to a close, starts to radically restructure its businesses in order to maintain margins. A proactive policy of external growth is adopted, mainly in Europe, with the acquisition of the defence electronics businesses of the Philips group in The other major operation is the acquisition of a controlling interest in Sextant Avionique (formed through the merger of the avionics businesses of Thomson-CSF and Aerospatiale). Numerous other acquisitions, large and small, significantly expand the Group's industrial base outside France, mainly in Europe. The non-french subsidiaries' share of consolidated revenues rises from 5% to 25% and 1997: Holdings in Crédit Lyonnais and SGS Thomson (now STMicroelectronics) are divested. The capital gains are used to finance further international growth. 1998: Reduction of the French State's interest in Thomson- CSF, from 58% to 40%, resulting from a contribution of assets by Alcatel and Dassault Industries, which become shareholders in the company. The assets contributed, namely Dassault Electronique and the professional and defence electronics businesses of Alcatel, strengthen Thomson-CSF's scope of business, consolidate its market positions in defence and industrial electronics, and expand its industrial operations in Europe, particularly in Germany, Italy and Norway. The operation also results in the formation of Alcatel Space, which brings together the space businesses of Alcatel, Aerospatiale and Thomson- CSF and is jointly owned by Thomson-CSF (49%) and Alcatel (51%) : After privatisation, the Group's multi-domestic strategy in defence markets is pursued throughout the 1990s in Europe, and then extended to South Africa, Australia, South Korea and Singapore After the friendly takeover in June 2000 of the British company Racal Electronics, the United Kingdom becomes the Group's second-largest domestic industrial base. 4_ Annual report THALES 2006

7 At the end of December 2000, Thomson-CSF, recently renamed Thales, forms the first transatlantic joint venture in the defence sector, and the world leader in air defence, with the American company Raytheon, Thales Raytheon Systems. In the space of just over ten years, the number of employees based outside France increased from less than 30% of the workforce to almost half. Thales, world leader in critical information systems These acquisitions as well as internal growth radically alter the Group's portfolio of businesses with increasing importance of civil applications, particularly on IT markets. In line with this strategic focus, a new organisation with three business areas defence, aerospace and information technology and services (IT&S) is introduced in July This organisation is intended to leverage the dual nature of the company's technology. In addition, with this clearer strategic focus in its civil activities, the company is ready to divest businesses that do not offer sufficient synergies with its defence and aerospace activities and in which it does not have favourable competitive positions. This divestment policy is also intended to reduce the debt contracted to finance the company's external growth operations. As of 2001, responding to the geopolitical and economic upheavals following 11 September 2001, Thales strengthens its focus on the most technology-intensive segments of the defence market, particularly network-centric warfare and force interoperability. At the same time, it expands its role as prime contractor and service provider to meet the needs of client countries faced with the growing complexity of programmes and the increasing sophistication of defence equipment and systems. In 2001, Thales divests its interests in Alcatel Space, whose largest market by far was, at that time, in satellites for civil telecommunications, Alcatel s core business. Thales continues to divest its non-strategic civil businesses, while at the same time consolidating and reorganising its growing civil security business. Thales pursues its multi-domestic development policy, acquires full control of several defence and aerospace subsidiaries originally held through joint ventures. Thales UK, now Britain s second-largest defence contractor, is selected for a number of major Ministry of Defence programmes, including the CVF future aircraft carriers, and in 2005 the company is appointed prime contractor for the UK s Watchkeeper UAV system, Europe's largest tactical surveillance programme. In 2004, with refocusing of the civil businesses almost complete, Thales announces a new organisation based on six divisions, each defined according to its respective markets, to facilitate implementation of the common technologies that underpin the company's world leadership in critical information systems for defence, aerospace and civil security. At the end of 2005, after five years of refocusing on its core capabilities, Thales regains the room for manoeuvre needed to pursue ambitious objectives in terms of revenue growth and financial performance, with organic growth targets based on a record order book, very low net debt providing the capacity to finance external growth operations, and the prospect of improved results backed by an ongoing programme to improve its competitive performance. A new stage in Thales s development begins in 2006: the Group materializes its external growth ambitions with two major agreements that significantly reshape the company's business portfolio, increase its focus on security in the broadest sense, for both military and civil markets, and strengthene its leadership and capabilities in critical information systems: - the agreement finalised at the end of March 2007 with the naval shipbuilder DCN and the French government, making Thales the main private shareholder and industry partner of one of the largest and most capable players in the worldwide naval defence sector, - the agreement with Alcatel-Lucent, signed in December 2006 and implemented in the first half of 2007, which brings Thales a global leadership position in security systems for ground transportation, and in satellites. These new businesses represent more than 2 billion euros in annual revenues, i.e., the equivalent of 20% of Thales's consolidated revenues in These two major agreements will bring a more equal balance to the civil and military security markets that Thales serves, with half of its business in defence and the rest fairly equally divided between aerospace and civil security, where the largest market is rail infrastructure. Annual report THALES 2006 _5

8 Selected highlights of January: ThalesRaytheonSystems begins development of advanced technology improvements to its Firefinder AN/TPQ-36 and AN/TPQ-37 weapon locating radars to extend system service life, reduce customer life cycle costs and significantly boost reliability, maintainability and performance. 9 February: Thales completes before the deadline the upgrade of the access control and ticketing infrastructure for Line 1 of the Turin Metro. The new system goes live ahead of contract schedule and in plenty of time for the influx of visitors for the Olympic Winter Games. 16 February: The Joint Staff of the French armed forces appoints Thales as prime contractor for the SCAPIN operational and strategic decision-support system. For the first time, SCAPIN will give French commanders a comprehensive picture from across all branches of the military. 21 February: Shanghai Airlines chooses Thales to supply and support training systems for its Boeing airliners. 22 February: British Mediterranean Airways signs a new purchase and support agreement with Thales for in-flight entertainment systems. Thales s TopSeries video and audio on-demand system entered service on BMED Airbus aircraft in Under this new contract, the TopSeries system will be installed on A320 and A321 aircraft on order and scheduled to enter service in April: Thales and Alcatel announce their intention to transfer Alcatel s satellite businesses and critical systems businesses for rail transport and security to Thales. 18 April: Thales is selected to provide France s Imprimerie Nationale (government printing office) with a complete secure system for the production and personalisation of the new electronic passport. 7 June: Thales wins a major contract to provide Saudi Arabia with communication infrastructure through its local subsidiary Stesa. Under the contract, Thales will design the network, install equipment and complete the necessary civil engineering tasks. Three local GSM operators will use the network: Etihad Etisalat, ITC and Bayanat. June: At the Eurosatory 2006 land/air defence exhibition in Paris, Thales and Rockwell Collins the leading military communication equipment suppliers with an industrial presence in Europe and the US sign a strategic agreement for the joint development of a new line of tactical ground communication products for the international market. 11 July: Thales wins three successive secure ticketing contracts to equip the three oldest lines of the Beijing Metro, all stations of Dubai s first metro network and the new Metronorte Line in Madrid. July: At the Farnborough International Air Show, Athensbased Aegean Airlines selects Thales to supply the flight management system and other key avionics equipment for its future Airbus A380 fleet. Deliveries are scheduled to begin in Spring Also at Farnborough, Thales signed a cooperation agreement with Russian planemaker Antonov to focus on special-mission aircraft and sold training simulators to Sukhoi for the Superjet100 and to Kingfisher Airlines for its A320 and ATR aircraft. 20 July: Thales sells most of its navigation business to Shah Capital Partners. This business is the creator of the Magellan brand of GPS equipment for the consumer recreation and automotive navigation markets. The divestment supports the refocus of Thales s security portfolio to professional applications. 24 July: Thales Communications Inc. wins a major contract with the US Army to supply 9,000 AN/VRC-111 vehicle adapter amplifiers. The AN/VRC-111 will extend the range of SINCGARS-capable radio systems installed by Thales on US Army vehicles and will enable additional capabilities and interoperable communications. 1 September: Thales is selected to supply the transmission subsystem and security subsystem for the FALCON future tactical network for British land forces. In particular, the new high-speed version of the TRC 4000 line-of-sight radio, already in service with France, Switzerland, Croatia and Austria, will form part of the transmission subsystem. 19 September: Through their alliance with SAIC and Raytheon in the United States, Thales and TRS achieve their first success in land-based ballistic missile defence for NATO. 6_ Annual report THALES 2006

9 October: At the Euronaval exhibition, Thales presents its broad-ranging capabilities in naval defence and maritime search & rescue, and its key role in support of the naval transformation process. The Group signs an agreement with Chilean naval shipyard ASMAR for the maintenance of Thales equipment on the four Chilean Navy frigates purchased from the Royal Netherlands Navy and currently being transferred. 12 October: Thales Australia is created as the Group acquires the remaining shares in ADI, a defence company previously owned jointly with Transfield Holdings. The operation was completed with the full authorisation of the Australian government. ADI thus joins the other fully owned Thales local subsidiaries Thales Underwater Systems, Air Traffic Management and Training & Simulation to form a single entity called Thales Australia. 10 November: Thales opens its new research centre on the campus of the École Polytechnique near Paris. The ceremony is attended by the French minister for higher education and research. The location at one of France s most prestigious engineering schools further illustrates the Group s commitment to promote cooperation with the university research community. 1 December: Thales and Alcatel-Lucent sign the final agreement for the transfer of Alcatel-Lucent s transport & security businesses and space businesses to Thales. The accord also provides for closer industrial cooperation between the two partners. 4 December: Thales is selected to provide communication services for the NATO International Security Assistance Force (ISAF) in Afghanistan. The Group is responsible for the provision, operation and maintenance of a secure voice and data communication network that will be progressively deployed to more than sixty ISAF points of presence in the country for a minimum of three years. 11 December: Thales makes a strategic breakthrough in the North American transport market with a first contract to supply an integrated secure ticketing system for the Toronto bus, tram and rail networks. Work will be carried out in cooperation with the Accenture Group. 12 December: The European Commission selects the consortium led by Thales to develop OSIRIS, the first integrated service of GMES (Global Monitoring for Environment and Security). GMES will create an EU-wide capability to acquire, analyse, process and distribute information in support of European environment and security directives. 22 December: Thales Nederland wins a contract with the Royal Danish Navy for the delivery of three anti-air warfare suites, each comprising one APAR multifunction radar, one SMART-L volume search radar and one fire control cluster. The suites will be installed on new patrol ships currently under construction. Annual report THALES 2006 _7

10 Key figures In m Order book at year-end 20,676 20,223 17,578 18,743 19,009 Order intake 10,818 12,781 9,375 10,887 10,677 Consolidated workforce at year-end 52,160 53,047) 55,705 57,439 60,662 France 29,180 29,835 30,872 32,219 33,236 United Kingdom 8,524 8,920 9,810 10,521 11,478 Other Europe 7,100 7,202 7,663 7,630 7,791 Rest of world 7,356 7,090 7,360 7,069 8,157 Financial data for 2004 to 2006 in accordance with IAS/IFRS In m Revenues (a) 10,264 10,263 10,283 France 3,064 2,995 2,982 United Kingdom 1,342 1,242 1,337 Other Europe 2,079 2,167 1,954 Rest of world 3,779 3,859 4,010 Income from operations Income of operating activities Net income Group share Earnings per share (in euros) Dividend per share (in euro) Total R&D (2,000) (1,900) (1,850) Company-funded R&D (534) (512) (444) Operating cash flows before working capital changes Capital expenditures (373) (352) (273) Net (acquisitions) disposals Net debt (net cash position) (91) Shareholders fund (excluding minority interests) 2,287 2,062 1,710 (a) Geographical breakdown of revenues by destination. 8_ Annual report THALES 2006

11 Financial data for 2002 to 2004 in accordance with French accounting standards In m Revenues (a) 10,288 10,569 11,105 France 2,984 2,748 2,554 United Kingdom 1,337 1,268 1,444 Other Europe 1,955 2,114 2,110 Rest of world 4,012 4,439 4,997 Operating income Income of operating activities Net income Group share Earnings per share (in euros) Net dividend per share (in euro) Total R&D (1,850) (1,850) (1,900) Company-funded R&D (incl. Capitalised) (436) (419) (460) Operating cash flows before working capital changes Capital expenditures (321) (350) (357) Proceeds from disposal of real estate assets Net (acquisitions) disposals Net debt (net cash position) ,320 Shareholders fund (excluding minority interests) 2,097 2,014 2,139 (a) Geographical breakdown of revenues by destination. Annual report THALES 2006 _9

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13 2006 Financial report I - Directors report A. Management discussion and analysis of 2006 financial statements. B. Risk factors. C. Recent events II - Consolidated financial statements A. Consolidated profit & loss account B. Consolidated balance sheet C. Consolidated statement of cash flows D. Consolidated statement of changes in shareholders equity and minority interests E. Notes to the consolidated financial statements F. List of main consolidated companies G. Statutory auditors report on the consolidated financial statements Annual report THALES 2006 _11

14 FINANCIAL REPORT I - Directors report A. Management discussion and analysis of 2006 financial statements Highlights and major trends in 2006 A new stage in Thales s development began in 2006, with two major agreements that significantly reshape the company's business portfolio, increase its focus on security in the broadest sense, for both military and civil markets, and strengthen its leadership and capabilities in critical information systems: - the agreement with Alcatel-Lucent on 1 December 2006 to transfer certain of the telecommunications group's businesses to Thales. These businesses generated 2006 revenues totalling 2.1 billion in ground transportation, civil security and satellites. The 1 December 2006 agreement provides for a transfer in two stages: (i) a contribution of assets, approved by the 5 January 2007 general meeting, leading to an increase in Alcatel-Lucent s interest in Thales from 9.5% to 21%, and (ii) a cash transaction involving Alcatel-Lucent satellite businesses, subject to the approval of the European Commission expected in the second quarter of 2007 (1), - the agreement with DCN and the French government in December 2005 for the transfer to DCN of some of Thales s naval businesses in France and the simultaneous acquisition by Thales of 25% of DCN s share capital. The final agreement was reached on 30 January 2007 and was expected to come into effect at the end of the first quarter of 2007 (2). These two major agreements will bring a more equal balance to the civil and military security markets that Thales serves, with half of its business in defence and the rest fairly equally divided between aerospace and civil security, where the largest market is rail infrastructure. In the summer of 2006, Thales virtually completed its divestment of non-strategic businesses, begun in 2000, selling the GPS positioning and navigation equipment businesses of its Thales Navigation subsidiary in California ( Magellan ). These businesses, which generated revenues of 224 million in 2005 and 113 million in the first half of 2006, were deconsolidated from the second half of In terms of business and results, 2006 was a highly positive year, marked by the following major trends: - Confirmed return to growth > organic revenue growth of 4.3% on a like-for-like basis, > a further increase in the order book at the end of the year, to 20,676 million, with a book-to-bill ratio of 1.05 supported by healthy recurring and diversified orders, despite the absence of major contracts on the scale of a number of awards in Marked improvement in financial performance > income from operations up 5% at 755 million and a further improvement in operating margin to 7.35%, compared with 7.05% the previous year, > net income up 16% to 388 million from 334 million in Positive net cash position at end-2006 of 91 million, compared with net debt of 398 million at end-2005, due largely to a 24% increase in operating cash flows to 754 million. 1. Revenues: confirmed return to growth Overall Organic In m change change Revenues 10,263 10,264 +0% +4% Order intake 12,781 10,818-15% -13% Order book at year-end 20,223 20,676 +2% +3% (1) Approved by the European Commission on 4 April 2007; effective transfer on 6 April (2) Transaction finalised on 29 March _ Annual report THALES 2006

15 Directors report Consolidated financial statements 1.1. Consolidated revenues In 2006, Thales Group revenues totalled 10,264 million, compared with 10,263 million in On a like-for-like basis, revenues grew by 4.3% (compared with organic growth of +3.8% in 2005). - Exchange rate fluctuations reduced revenues by 73 million. Changes in the scope of consolidation further to the divestment of non-core businesses resulted in a net reduction in revenues of 345 million. The main businesses divested were Thales Broadcast & Multimedia and the High Tech Optics operations, which were deconsolidated at end-2005, and the satellite navigation business, which was deconsolidated from 30 June The breakdown by division shows a reduction in revenues for Naval, limited to 10% despite the completion of the Sawari 2 contract, while Security and Land & Joint Systems recorded double-digit growth (+13% and +10% respectively). a. Consolidated revenues by division Overall Organic In m change change Aerospace 2,335 2,473 +6% +6% Air Systems 1,596 1,589-0% +0% Land & Joint Systems 2,178 2, % +10% Naval 1,484 1,330-10% -10% Security 1,186 1,205 +2% +13% Services 1,183 1,214 +3% +5% Other and divested businesses ns% ns% Consolidated revenues 10,263 10,264 0% +4% - The Aerospace division recorded +6% organic growth, reflecting a strong performance by the division s civil businesses, which increased revenues by more than 20% over the year, particularly for in-flight entertainment systems, where sales nearly doubled compared with the previous year. Sales of avionics systems continued to rise in line with the increased pace of Airbus production, and, to a lesser extent, deliveries for Bombardier regional aircraft and billings on the Sukhoi regional aircraft programme, which is in the development phase. In military markets, 2006 revenues fell slightly overall, although increased sales of avionics systems on the A400M and Rafale France programmes and the Watchkeeper UAVbased surveillance programme in the United Kingdom partly offset the reduction in billings linked to the completion of a number of major export programmes. - Revenues of the Air Systems division remained stable compared with the previous year on a like-for-like basis, although a strong recovery (+11%) was recorded in the last quarter. Billings on surface radars were lower because several naval radar contracts in Asia (South Korea and Singapore) reached completion and new orders in this segment only had a moderate impact on revenues by end Air defence systems business remained solid in 2006 overall as work continued on the FSAF (Franco-Italian cooperative programme), KSAM (South Korea) and VT1 programmes for France and Finland. Revenues from the air defence businesses of the joint venture ThalesRaytheonSystems were stable over the first three quarters of 2006, before recording a marked increase in the fourth quarter. The main revenue streams from this business were the ACCS Loc1 programme for NATO and the support services contract for the US Army s Firefinder radars. Revenues from air traffic management businesses were similar to the previous year, with a marked increase in sales of air traffic control radars offsetting lower revenues from major upgrade programmes that were completed in 2005 or 2006 in Brazil, New Zealand and Kenya. - After two years of virtually flat growth, the Land & Joint Systems division recorded a 10% increase in revenues in The highest rates of revenue growth came from the United States, where a new complement of tactical communications equipment is being delivered to the US Annual report THALES 2006 _13

16 FINANCIAL REPORT military, and in France, with the deployment of the largescale Socrate infrastructure network and the Syracuse III satellite communications programme. In the United Kingdom, the division recorded its first revenues on the Falcon tactical network programme in the fourth quarter. The order for this programme was booked mid-year - As expected, Naval division revenues fell as a result of the completion of the Sawari 2 frigate programme for Saudi Arabia. The overall reduction in revenues was limited (10%), however, as the division commenced billings on the P75 submarine programme for India, the cooperative Franco-Italian FREMM programme, and the ongoing demonstration phase of the CVF aircraft carrier programme in the United Kingdom. The positive impact of these new programmes was reflected in the upturn in revenues recorded in the fourth quarter: sales by the division increased by 13% in the fourth quarter of 2006, compared with an average decrease of 21% over the first nine months of the year. The completion of the Sawari 2 programme no longer impacted the division s revenues in the fourth quarter. - Most of Thales s Security businesses are experiencing positive growth: sales of security systems grew as the communication infrastructure contract for Etisalat in Saudi Arabia ramped up, and continued brisk growth in secure transactions and components, which were driven in particular by the development of digital technology in medical imaging and the up-cycle in the satellite market. - The Services division recorded 5% revenue growth for the full year, with quite significant variations between different businesses. In particular, revenues from telecom services for the rail transport sector in the United Kingdom returned to strong growth in the second half of the year. The division also sustained its growth in IT services, while training and simulation sales grew at a more moderate rate. b. Revenues by geographic area Destination Overall m % m % change France 2,995 29% 3,064 30% +2% United Kingdom 1,242 12% 1,342 13% +8% Other European countries 2,167 21% 2,079 20% -4% Total Europe 6,404 61% 6,485 63% +1% North America 1,068 10% 1,192 12% +12% Near & Middle East 884 9% 617 6% -30% Asia-Pacific 1,537 15% 1,577 15% +3% Africa & Latin America 370 5% 393 4% +6% Total outside Europe 3,859 39% 3,779 37% -2% Total 10, % 10, % 0% The proportion of revenues billed in Europe rose slightly, to 63%, as a result of higher sales in the United Kingdom, driven in particular by stronger activity on the Watchkeeper programme, billings on the CVF and Falcon programmes and the return to growth in telecom services for the rail transport sector. The moderate growth in revenues billed in France includes a sharp increase in billings on major military network programmes and the FSAF air defence system, as well as civil sales of security systems and services, but lower revenues on the Rafale France programme. Most of the decrease in revenues billed in other European countries was the result of billing schedules on a number of ongoing defence programmes. Despite the divestment of the navigation business in mid- 2006, Thales again recorded double-digit growth (12%) in revenues billed in North America in 2006, particularly for defence communications and in-flight entertainment systems and support services for airlines. The large reduction in billings in the Middle East is a cyclical effect attributable to the completion of several major contracts in Saudi Arabia (Sawari 2 frigates). High order intake from this region in 2006 ( 1,088 million) will lead to higher billings from the 2007 financial year. The small progression in revenues in the Asia-Pacific region combines, on the one hand, the completion of a number of naval and airport modernisation programmes and, on the other hand, a marked increase in revenues from civil aerospace support services, satellite components, optronic systems and defence communication equipment, leading to a moderate overall increase in revenues billed in this region. Asia-Pacific still accounts for more Thales revenues by destination than any other region except Europe. 14_ Annual report THALES 2006

17 Directors report Consolidated financial statements 1.2. Orders The book-to-bill ratio was greater than 1 in 2005 and the first half of 2006, and Thales recorded sustained growth in orders worth 100 million or less. The full-year figures confirm both trends, with 11% overall growth in these smaller orders and an overall book-to-bill ratio of 1.05 for Total order intake, at 10,818 million, was 15% lower (13% lower on a like-for-like basis) than the exceptionally high order intake recorded in 2005 ( 12,781 million), which included 3,260 million for three contracts each worth more than 500 million: the Franco-Italian FREMM frigate programme and India s Scorpene-class P75 submarine programme for the Naval division, and the United Kingdom s Watchkeeper UAV-based surveillance programme for the Aerospace division. None of the new orders booked in 2006 is worth more than 200 million; eight are worth more than 100 million. a. Order intake by division Overall change In m Aerospace 3,164 2,369-25% Air Systems 1,202 1, % Land & Joint Systems 2,364 2, % Naval 3,237 1,254-61% Security 1,421 1,525 +7% Services 1,101 1, % Other and divested businesses ns% Total order bookings 12,781 10,818-15% Total of orders worth less than 100 million 8,630 9, % - Orders booked by the Aerospace division in 2006 were 25% lower than in 2005, when order intake included almost 1 billion for the Watchkeeper programme in the United Kingdom. Excluding this major contract, the yearon-year increase in the division s order intake would have stood at 3%. Civil orders were relatively solid, driven by growth in in-flight entertainment, higher Airbus production rates and a good level of support business. In military markets, in addition to Watchkeeper, highlights of the year were the pursuit of the Rafale France programme, particularly the roadmap for the development of the active phased-array radar, the upgrade contract for Morocco s Mirage F1 combat aircraft and the avionics contract for the British Army s Future Lynx helicopter. - The sharp increase in orders booked by the Air Systems division (+21%) is the result of strong business in surface radars and civil radars, and good sales performance in services, both in defence markets, particularly for through-life support on Saudi Arabia s air defence systems, and in civil markets, with a new contract to upgrade air traffic control radars in Brazil. - The Land & Joint Systems division again recorded a sharp rise in order intake (+21%), both in defence communications and networks in France, the United Kingdom and the United States (with order intake close to 300 million), and in optronics, particularly in France and the United Kingdom. The division significantly increased its order intake in all regions. - After an exceptional year in 2005, when new business included orders worth 2.3 billion for the first phase of the Franco-Italian FREMM multi-mission frigate programme and confirmation of the Scorpene submarine contract for India, order intake by the Naval division fell by 61% and represented a book-to-bill ratio of The first orders in 2006 were to equip several corvettes in partnership with Navantia as well as patrol boats for Denmark. Annual report THALES 2006 _15

18 FINANCIAL REPORT - The Security division recorded an increase in order intake of 7% (+17% on a like-for-like basis excluding the impact of the deconsolidation of the GPS navigation business in the second half of the year). This increase was mainly driven by new orders in information system security with the secure GSM network contract for Etisalat in Saudi Arabia, and, to a lesser extent by secure transactions and components. In the transport sector, order intake stabilised after strong growth in The 18% rise in order intake by the Services division came mainly from information systems, particularly IT outsourcing, telecom services for Network Rail and the London Underground, and defence services in Australia. Order intake by the training and simulation business was roughly at the same high level as in the previous year, thanks to strong growth in simulator orders for commercial airlines. b. Orders by geographic area Destination Overall m % m % change France 4,265 33% 2,528 23% -41% United Kingdom 2,133 17% 1,306 12% -39% Other European countries 2,311 18% 2,128 20% -8% Total Europe 8,709 68% 5,962 55% -32% book-to-bill North America 1,458 12% 1,278 12% -12% Near & Middle East 367 3% 1,088 10% +197% Asia-Pacific 1,816 14% 1,760 16% -3% Africa & Latin America 431 3% 730 7% +70% Total outside Europe 4,072 32% 4,856 45% +19% book-to-bill Total 12, % 10, % -15% As a proportion of total order intake for the year, orders booked from France and the United Kingdom were significantly lower than in 2005, when two major orders totalling 2.7 billion were placed by these countries (FREMM and Watchkeeper). Similarly, new orders in the rest of Europe were lower than in 2005, when major new contracts included the development of the avionics for Sukhoi s RRJ and the upgrade of the F122 / F123 frigates for the German Navy. The apparent reduction in order intake in North America was entirely the result of the divestment of, in 2005, the broadcast and multimedia activities and high-tech optics and, in 2006, GPS navigation businesses, all of which have a substantial presence in the United States. With the same scope of consolidation, order intake rose slightly, representing a book-to-bill ratio of 1.07, and this region contributed 12% to Group order intake in 2006, the same percentage as in Order intake in Asia was strong, with major new orders in South Korea, a naval programme for Indonesia, several defence orders in Australia and in-flight entertainment systems for an Indian airline sustaining total order intake at almost the same level as in 2005, when new orders included the 580 million euro Indian submarine contract and orders booked by the high tech optics business in Singapore, which was divested at the end of the year. The book-to-bill ratio stood at 1.12 for 2006 compared with 1.18 for _ Annual report THALES 2006

19 Directors report Consolidated financial statements Order intake almost tripled in the Middle East with a new series of through-life support contracts for air defence systems, the deployment of Etisalat s secure GSM network in Saudi Arabia, and a contract to supply electronic warfare equipment to the United Arab Emirates. At 31 December 2006, the order book stood at 20,676 million, the highest level ever recorded, and was 2% higher than at end-2005 ( 20,223 million). The order book represents 24.2 months of revenues compared with 23.6 months at end The largest order books by division were for Naval (43 months of revenues), Air Systems (29 months) and Aerospace (25 months), ahead of Land & Joint (20 months) and Services (19 months). The order book for the Security division, whose market cycles are shorter, represented 12 months of revenues. Note that the year-end order book for the Aerospace division, and the Group as a whole, does not include avionics equipment that will be purchased from Thales for Airbus aircraft already on firm order from airlines: Airbus only orders this equipment from Thales a few weeks before they are installed on the aircraft. End-2006, the value of these implicit orders was more than $1.5 billion. 2. Financial performance: significant improvement in 2006 The increase in net income in 2006 is due to the following favourable trends: - a 4.5% improvement in current income from operations, from 722 to 755 million, with a further rise in operating margin to 7.35% of revenues, compared with 7.05% in 2005, - a 5% increase in income of operating activities, from 549 to 576 million, after restructuring costs somewhat lower than the previous year, and despite significantly reduced capital gains from divestments, - financial results improved from (93) to (73) million as a consequence of the reduction of net financial debt over the year and a reduction in other components of pension charge. Thales showed a net profit, Group share, of 388 million for the 2006 financial year, 16 million higher than the previous year s figure of 344 million. Summarised profit and loss account In m Change Consolidated revenues 10,263 10, Income from operations Restructuring costs (213) (193) +20 Gain (loss) on disposal of assets and other exceptional items Income of operating activities Other financial income (expense) (93) (73) +20 Other components of pension charge (34) (19) +15 Income tax (87) (101) -14 Equity in income of unconsolidated affiliates Net income (loss) share of minority interests (9) (3) -6 Net income (loss), Group share Annual report THALES 2006 _17

20 FINANCIAL REPORT 2.1. Income from operations Income from operations increased by 4.5% to 755 million and represented an operating margin on revenues of 7.35% compared with 7.05% in Income generated by the six divisions increased by nearly 30 million (+4%) overall, to 775 compared with 746 million in This corresponds to an operating margin of 7.55%, compared with 7.26% in These positive trends were obtained despite the negative impact of exchange rates, estimated at 46 million, and mainly caused by the dollar parity. With constant exchange rates, income from operations increased by 11%, reflecting both the first results of restructuring measures implemented under the Optimum plan and the positive effects of the portfolio refocusing policy that has been ongoing for several years. Income from operations by division In m Change Aerospace % % of revenues 8.9% 8.1% Air systems % % of revenues 7.7% 8.7% Land & Joint Systems % % of revenues 5.9% 7.7% Naval % % of revenues 10.1% 7.5% Security % % of revenues 4.7% 5.6% Services % % of revenues 6.8% 6.7% Division total % % of revenues 7.26% 7.55% Other and divested businesses (24) (20) Ns Income from operations % % of revenues 7.03% 7.35% The Aerospace division was the most affected by exchange rate fluctuations, with slightly lower income of 201 million. However the division posted operating margin of around 8%. In its defence businesses, the division is implementing a restructuring programme to adapt to a structural decline in orders from France. In civil businesses, the division is continuing to invest heavily in R&D and marketing and sales to support the rapid development of the in-flight entertainment business. The Air Systems posted income of 139 million and an operating margin of 8.7%, markedly higher than the year before, with good performance from the joint venture with Raytheon and the air defence systems business. The contribution from the air traffic management and missile electronics businesses remained the same as in The sharp increase in income and margin for the Land & Joint Systems division, to 186 million and 7.7%, was driven by the growth in revenues. The greatest improvements were posted in the United States, where higher volumes led to stronger margins, and in France, with the improvement in the optronics business. As expected, the Naval division s income, 100 million, was sharply down as a result of the end of the Sawari 2 contract. However, the division maintained an operating margin of 7.5% as a result of growth in the support services and underwater electronics business, which are benefiting from the effects of the productivity plan. The Security division s income from operations was 68 m despite the operating loss of 17 million booked in the first half of 2006 for the navigation businesses divested in the summer. In 2005, these businesses posted a slight profit. Income from other businesses rose more than 40% as a result of improvements in most sectors, particularly transport, secure transactions and components. With a 5% improvement in income at constant exchange rates, the Services division raised its operating margin to nearly 7%, due largely to better management of indirect costs, particularly in IT services. The non-division operating losses, of (24) million in 2005 and (20) million in 2006, include the income (loss) from businesses divested the previous year and other income (loss) from operations not managed by divisions: 18_ Annual report THALES 2006

21 Directors report Consolidated financial statements - total income from operations of businesses divested in 2005, mainly Thales Broadcast & Multimedia and the high tech optics business, was 13 million in the year of their divestment, - other non division operating results were a loss of (37) million in 2005 and of (20) million in These operating losses are mainly attributable to costs related to real estate vacated by operating entities, whose rent is paid by the parent company pending reallocation or expiration of lease. The corresponding charge booked in 2006 was reduced by 9 million as the cost of these vacated premises fell. In 2005, this charge also included a provision of 8 million for anticipated costs of vacating a major site in the Paris area; this provision was fully used in Analysis of the components of income from operations shows that the 4.5% increase from 2005 to 2006, while revenues were stable, was due to a 19 million increase in gross margin and a reduction in indirect costs of 14 million. Indirect costs fell by 1% overall, with a 1% reduction in research and development costs as well as in marketing and sales expenses partly offset by a 1% increase for general and administrative expenses. Total research and development expenditure rose roughly 4% in 2006 to just over 2 billion, compared with 1.90 billion in 2005 and 1.85 billion in 2004 and Company-funded research and development, at 534 million in 2006 (4% higher than the 2005 figure of 512 million), accounted for just over one-quarter of the total. Company-funded research and development expenditure breaks down into 157 million capitalised under IAS 38 (compared with 138 million in 2005), 361 million charged as an expense ( 366 million in 2005), and 16 million (compared with 8 million in 2005 and 2004) in research tax credit from the French authorities. Most R&D work is conducted by the operating units. Advanced research ( Research and Technology ) accounted for just under one-fifth of total expenditure ( 360 million in 2006) and includes concept design, technology demonstrators and technological research. Development work accounts for four-fifths of the total ( 1,675 million in 2006), divided fairly equally between equipment development and systems development. An estimated 20,000 Thales employees worldwide, 75% of them engineers, are involved in research and development activities: 5,200 in Aerospace, 5,400 in Land and Joint Systems, 4,000 in Air Systems, 2,500 in Security and Services, and 2,400 in Naval. The central laboratories and departments, under Thales Research & Technology, employ some 500 research staff. Company-funded research and development includes technological research and development projects conducted by both Thales Research & Technology central laboratories on key technologies, and by the divisions on system of systems architecture. A significant proportion of company-funded research and development supports the Group s major strategic programmes, such as those of the Aerospace division (avionics equipment, airborne systems, UAV systems, in-flight entertainment, etc.), the Land & Joint Systems division (Battlefield Transformation Centre, tactical networks, software radio, etc.), the Air Systems division (ATM software) or the new Security Solutions & Services division (e-government, major administrative portals). Marketing and sales expenses ( 856 million compared with 868 million in 2005) fell slightly: the deconsolidation of businesses with high marketing and sales expenses had a positive impact on the overall figure, but, on a like-for-like basis, bid and demonstration costs increased, particularly for defence markets, as did commercial and support services for certain civil business, such as in-flight entertainment. General and administrative expenses were virtually stable, at 459 million compared with 456 million. Income of operating activities rose by 5% to 576 million, compared with 549 million in This figure includes 193 million in restructuring costs, compared with 213 million in 2005, for the Optimum plan announced in March Provisions of around 400 million were booked in 2005 and 2006 for this exceptional plan, which aims to generate approximately 300 million in full-year savings by Income from operations also includes a 23 million gain from disposals, mainly the balance from the gain of 41 million from the divestment of Embraer shares and the loss of (25) million booked for the divestment of the GPS navigation equipment businesses Other results - Financial results improved by 20 million to (73) million, reflecting a lower average debt over the year, estimated to be 736 million compared with 1,140 million in 2005, and a lower average interest rate, down from 6.6% to 6.2%. Other financial expense mainly includes the accounting impact of hedging activities, particularly the change in fair value of derivative exchange instruments and impairment of some investment securities. Annual report THALES 2006 _19